FINANCIAL MANAGEMENT: AN OVERVIEW

Introduction
The primary task of Financial Manager is to deal with funds. Management of
funds is an important aspect of Financial Management. In a business undertaking or
in an educational institution or in a hospital or in an art society or else where
management of funds is the primary concern of the Financial Management.
Finance is regarded as the lifeblood of a business enterprise. This is because
in the modern money-oriented economy finance is one of the basic foundations of all
kinds of economic activities. Without adequate finance no business can survive or
accomplish its obectives. In general! finance may be defined as the provision of
money at the time it is wanted. Thus! finance refers to making provision of money at
the time when it is required.
Meaning of Business Finance
"usiness finance is that business activity which is concerned with the
acquisition and conservation of capital funds in meeting financial needs and overall
obectives of a business enterprise. In other words! it refers to the process of raising!
providing and administering of money used in a business concern.
Wheeler defines business finance as #That "usiness activity! which is
concerned with the acquisition and conservation of capital funds in meeting the
financial needs and over all obectives of business enterprise$.
In the words of %rather and Wert! #"usiness Finance deals primarily with
raising! administering and disbursing funds by privately owned business units
operating in non-financial fields of industry$.
Finance Function
Finance Function refers to the providing of funds needed by a business
concern on most suitable terms. In other words! it refers to the raising of funds and
their effective utili&ation. It does not stop only by finding out sources and raising of
funds but it also covers proper utili&ation of funds.
Obecti!es of Finance Function
The main aim of finance function is to arrange adequate funds as required by
the business enterprise from time to time.
The main obectives of finance function are' -
1. Acquiring sufficient funds
The main obective of financial function is to estimate the financial needs of
the business and then finding out suitable sources for raising them. If funds
are required for long-term investments then long term sources like issue of
(
shares! debentures! long-term loans! etc. may be preferred. If funds are
required for working capital purposes then short-term sources like bank
credit! trade credit! factoring! etc. may be used.
2. Proper utilization of funds
)nother important obective of finance function is proper utili&ation of funds.
The funds must be used in such a way that the ma*imum benefit is derived
from them. The returns must be more than their e*pected cost.
3. Increasing profitability
When funds are used effectively it may lead to increase in profitability. The
finance function must ensure availability of sufficient funds at all times.
4. Maximizing concerns alue
Finance function also aims at ma*imi&ing the value of the firm. +sually the
value of the firm is determined by its profitability. The value of the firm is also
influenced by other factors such as sources of funds! cost of capital! money
market conditions! etc.
Organi"ation C#art of Finance Function
The ,hief Finance -*ecutive worked directly under the %resident or the
Managing .irector of the company. "esides routine work! he keeps the "oard of
.irectors informed about all the phases of business activity! including economic!
social and political developments affecting the business behavior. /e also furnishes
information about the financial status of the company by reviewing it from time to
time. The chief finance e*ecutive may have different officers under him to carry out
his functions. "roadly! his functions are divided into two' 0i1 Treasury Functions and
0ii1 ,ontrol Functions.
)n 2rgani&ation ,hart of Finance Function in a big organi&ation is given
below.
ORGANI$ATION C%ART OF FINANCE F&NCTION
BOARD OF DIRECTORS
PRESIDENT
V.P. (Production) V.P. (Finance) V.P. (Sales)
Treasurer Controller
Credit Management Corporate General Accounting
Cash Management Taxes
Baning !elations "nternal Audit
Port#olio Management Budgeting
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Meaning ' (efinition of Financia) Manage*ent
The term Financial Management has been defined differently by different
authors. Financial management refers to that part of the management activity! which
is concerned with the planning! and controlling of firm4s financial resources. It deals
with finding out various sources for raising funds and most appropriate use of such
funds.
Thus! financial management is considered as a subect! which deals in
planning and control of financial operations of corporate enterprises. This deals with
the procurement of funds and their effective utili&ation.
)ccording to 5olomon! #Financial Management is concerned with the efficient
use of an important economic resource! namely ,apital Funds$.
Obecti!es of Financia) Manage*ent
The basic obectives of financial management can be broadly classified into
two categories! namely' -
a1 "asic 2bectives
b1 2ther 2bectives
Basic Obecti!es
The basic obectives of financial management have been
a1 %rofit Ma*imi&ation and
b1 Wealth Ma*imi&ation
Profit Maximization
%rofit earning is the main aim of every economic activity. ) business being an
economic institution must earn profit to cover its costs and provide funds for growth.
6o business can survive without earning profit. %rofit ma*imi&ation refers to
increasing the profit of a business organi&ation to the ma*imum e*tent possible. In
other words! it denotes the ma*imum profit to be earned by an organi&ation in a
given time period.
T#e fo))o+ing argu*ents are ad!anced in fa!or of ,rofit Ma-i*i"ation: .
a1 When profit earning is the main aim of the business then! profit ma*imi&ation
should be its main obective.
b1 %rofitability is a barometer for measuring efficiency and economic prosperity
of a business enterprise.
c1 %rofits are the main sources of finance for the growth and development of a
business.
d1 ) business will be able to survive under unfavorable situations like recession!
depression! sever competition! etc. only if it has some past earnings.
e1 %rofitability is essential for fulfilling social needs also.
f1 %rofit ma*imi&ation attracts the investors to invest their savings in securities
of the firm.
g1 %rofit indicates the efficient use of funds of the business concern.
h1 The goodwill of the firm is based on profitability
7
T#e fo))o+ing argu*ents are ad!anced against ,rofit Ma-i*i"ation: .
a1 The term profit is vague and it cannot be precisely defined. It means different
things for different people.
b1 %rofit ma*imi&ation obective ignores the time value of money and does not
consider the magnitude and timing of earnings. It treats all earnings as equal
though they occur in different periods.
c1 It does not take into consideration the risk of the prospective earning stream.
d1 %rofit ma*imi&ation encourages corrupt practices to increase the profit.
e1 The effect of dividend policy on the market price of shares is also not
considered in the obective of profit ma*imi&ation.
f1 %rofit ma*imi&ation attracts cutthroat competition.
g1 /uge amount of profit may invite government intervention.
!ealt" Maximization
Wealth ma*imi&ation refers to the increase in value of capital of the firm in
terms of market price. This increase in market price is determined by the volume of
capital! the capital structure! the cost of capital and rate of return to the investors.
%o+ to *a-i*i"e +ea)t#/
In order to ma*imi&e wealth! a firm should take the following steps' -
1. Aoid "ig" leel of ris#s
The firm should avoid such proects! which involve high profits together with
high risks.
2. Pay $iidends
%ayment of regular dividends increases the firm4s reputation and consequently
the value of the firm4s shares.
3. Maintain %ro&t" in sales
The firm should have a large! stable and diversified volume of sales. This
protects the firm from adverse consequences of recessions! changes in
customer4s preferences or fall in demand for the firm4s products on account of
other reasons.
4. Maintain price of firm's equity s"ares
Ma*imi&ation of shareholders wealth is closely connected with the
ma*imi&ation of the value of the firm4s equity shares. ) firm can take a
number of steps to maintain the value of equity shares at reasonable levels.
Ad!antages of Wea)t# Ma-i*i"ation
a1 Wealth Ma*imi&ation considers the concept of time value of money.
b1 Wealth Ma*imi&ation takes care of economic welfare of the owner! which is
reflected in the market share of a company.
c1 Wealth Ma*imi&ation also takes care of creditors! employees! public and
management.
d1 Wealth Ma*imi&ation guides the management in formulating realistic dividend
policy.
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(isad!antages of Wea)t# Ma-i*i"ation
The Wealth Ma*imi&ation has been critici&ed on the following grounds' -
a1 Wealth Ma*imi&ation is a prescriptive idea. The obective is not descriptive of
what the firms actually do.
b1 The obective of wealth ma*imi&ation is not necessarily socially desirable.
In conclusion! it can be said that the firm should follow the obective of wealth
ma*imi&ation to a e*tent it is viable in the conte*t of its social responsibility and
constraints imposed by the government.
Ot#er Obecti!es
"esides! the above basic obectives the following are the other obectives of
financial management.
(1 -nsuring a fair return to a shareholder.
31 "uilding up resource for growth and e*pansion.
71 -nsuring ma*imum operational efficiency by efficient and effective utili&ation
of finances.
81 -nsuring financial discipline in the organi&ation.
Functions of Financia) Manage*ent
)t present Financial Management is not restricted to raising and allocating
funds. It also includes the study of financial institutions like stock e*change! capital
markets! etc. 5ome of the important functions performed by Financial Management
are' -
1( Planning t"e )inancial *eeds
The first task of a financial e*ecutive is to determine the finance needs of the
concern. The funds are needed to meet fi*ed assets and working capital
needs. The requirement of fi*ed assets is related to the type of industry. The
working capital needs depend upon the scale of operation..
2( Acquisition of )unds
)fter making the finance forecasting and planning! the ne*t step will be to
acquire funds. The finance e*ecutive must find out the various sources
available for acquiring funds. These sources may be long-term or short-term.
The various long-term sources are issue of shares! debentures! long-term
loans from financial institutions! etc. The various short-term sources are bank
credit i.e.! short-term loans! cash credit! overdraft facilities! discounting of
bills of e*change! trade credit! factoring! lease finance! etc.
3( Inestment of )unds
Investment decision refers to planning the deployment of available capital for
the purpose of ma*imi&ation the long-term profitability of the firm. It is the
firm4s decision to invest its current funds most efficiently in long-term
activities in anticipation of flow of future benefits over a series of year. ,apital
budgeting decisions are the most crucial and critical business decisions
because the success or failure of a concern based on these decisions.
9
4( $iidend decision
.ividend is the portion of earning! which is distribution among the
shareholders. .ividend policy on the other hand determines the division of
earning between payments to shareholders and retains earnings. Formulation
of a proper dividend policy is one of maor financial decision taken by the
finance e*ecutive.
+( !or#ing ,apital Management
Working capital refers to the e*cess of current assets over current liabilities.
In other words! it is net current assets or net working capital. Working capital
is essential to maintain the smooth running of business. 6o business can
survive without adequate amount of working capital proper management of
working capital is an important area of financial management.
-( Analysis and Interpretation of )inancial .tatement
The analysis and interpretation of financial statements is one of the important
tasks of a financial e*ecutive. /e is e*pected to know the short-term! long-
term solvency and profitability of the concern.
/( Profit planning and control
%rofit planning and control is an important responsibility of a financial
management. The profit planning and control also influence the declaration of
dividends! creation of reserves! replacement of assets! redemption of debts!
future productions! future e*pansions.! etc.
Ro)e of Finance Manager
The changed business environment has widened the role of a finance
manager. The development of multi-national companies! innovation of information
technology! intense competition! etc. have increased the needs for financial planning
and control. ) finance manager is e*pected to perform the following functions' -
1( )unds 0equirement $ecision
This is the most important function performed by the finance manager. )
careful estimate has to be made about the total funds required for both the
fi*ed and working capital requirements.
2( )inancing $ecision
This is an important decision for the finance manager. It is concerned with
determination of the quantum of finance! the amount that can be raised from
each source and the cost and other consequences involved.
3( Inestment $ecision
This comprises decisions relating to investment in both fi*ed assets and
current assets. The finance manger has to evaluate different capital
investment proposals and select the best keeping in view the overall obective
of the enterprise.
4( $iidend $ecision
The establishment of dividend policy is another important function of finance
manager. The dividend decision involves the determination of the percentage
:
of profits earned by the enterprise! which is to be paid to shareholders and
percentage of profits that should be retained as retained earnings.
+( 1aluation $ecisions
) number of merger and consolidation take place in the present competitive
industrial world. ) finance manager must assist the management in making
valuations.
)part from the above main functions! following subsidiary functions are also
performed by the finance manager' -
a( 2o ensure supply of funds to all parts of t"e organization
It is also the function of the finance manager to ensure supply of funds to
all parts of the organi&ation to help in smooth operations of the activities
of the organi&ation.
b( 2o ealuate )inancial Performance
The financial performance of the various units of the organi&ation is to be
evaluated from time to time to detect any fault in the financial policy.
c( 2o negotiate &it" 3an#er4 )inancial Institutions4 etc.
The financial e*ecutive must negotiate with "anker! Financial Institutions
and other suppliers of credit.
d( 2o #eep trac# of .toc# 5xc"ange
The financial e*ecutive must keep track of stock e*change quotations and
behavior of stock market prices! etc.
Financia) ,)anning
Finance is an important function of business. The application of planning to
this function is Financial %lanning. Financial %lanning is mainly concerned with the
economical procurement of funds and profitable use of such funds.
) financial plan is a statement of estimating the amount of capital and
determining its composition. It states' -
a1 The quantum of finance is the amount needed for implementing the business
plan.
b1 The patterns of financing i.e.! the form and proportion of various corporate
securities to be issued to raise the required amount! and
c1 The policies to be pursued for the flotation of various corporate securities.
Need for Financia) ,)anning
The need for financial planning arises to ensure the following obectives' -
a1 To determine the quantum of finance to be raised.
b1 To determine patterns of financing i.e.! the form and proportion of various
securities.
c1 To determine policies to be pursued for the floatation of various corporate
securities.
d1 To maintain liquidity throughout the year.
;
e1 To ascertain the availability of surplus funds for e*penses or e*ternal
investments.
f1 To ensure availability of sufficient cash for meeting e*penditure! emergencies
and fluctuations in the level of working capital.
g1 To eliminate waste resulting from comple*ity of operation.
h1 To prepare plans to renew or replace the e*isting assets.
i1 To prepare policies and procedure to co-ordinate various financial operations
of the enterprise.
0te1s in Financia) ,)anning
Financial %lanning involves the following steps' -
1( 5stimating )inancial 6b7ecties
The financial obectives of a company i.e.! both short-term and long-term
obectives must be clearly and carefully prepared.
2( )ormulating )inancial Policies
Financial policies are guides to all actions! which deal with procuring!
administering! and disbursing the funds of business firms.
3( )ormulating Procedures
The procedures are formed to ensure consistency of actions. The procedures
follow the formulation of policies.
4( Proiding for )lexibility
The financial planning should ensure fle*ibility in obectives! policies and
procedures! so as to adust according to changing economic situations.
,rinci1)es Go!erning a Financia) ,)an
The financial plan should be prepared keeping in view the following principles.
1( .implicity
) financial plan should be simple and easily understood by everybody. )
complicated financial structure creates complications and confusions.
2( ,lear ,ut 6b7ecties
Financial planning should be done by keeping in view the overall obectives of
the company. The obectives must be clear and unambiguous.
3( )lexibility
The financial plan should not be rigid. It should be fle*ible i.e.! capable of
being adusted according to the needs and circumstances. Fle*ibility is helpful
in making changes in plan with minimum possible delay.
4( 8ong9term 1ie&
The financial plan should be formulated keeping in view the long-term needs
of the organi&ation rather than finding out easiest way of obtaining the
original capital.
<
+( )oresig"t
The financial plan should be prepared keeping in view the future requirements
of capital for the business.
-( 8iquidity
Financial planning should ensure liquidity and solvency of the enterprise.
)dequate liquidity gives a degree of fle*ibility too.
/( ,ontingencies
The financial plan should keep in view the requirements of funds for
contingencies likely to arise in future.
:( 5conomy
The cost of raising the capital should be kept minimum. It should not impose
any unnecessary burden on the company. This is possible by having a proper
debt- equity mi*.
;( 6ptimum <se
The financial plan should provide for meeting the genuine needs of the
company. The available funds must be used effectively and efficiently.
C#a1ter Roundu1
"usiness Finance refers to that business activity which is concerned with the
acquisition and conservation of capital funds in meeting the financial needs
and overall obectives of business enterprise.
Finance function refers to the providing of funds by a business concern on
most suitable terms.
Financial management refers to that part of management activity which is
concerned with planning and controlling of firm4s financial resources. It deals
with finding out various sources for raising funds and most appropriate use of
such funds.
%rofit ma*imi&ation refers to increase in the profit of a business organi&ation
to the ma*imum possible e*tent. In other words! it denotes the ma*imum
profit to be earned in an organi&ation in a given time period.
Wealth ma*imi&ation refers to the increase in the value of capital of the firm
in terms of market price. The increase in market price is determines the value
of capital! capital structure! cost of capital and rate of return to the investors
etc..
2uic3 2ui"
(. .efine business finance.
3. What is meant by finance function=
7. What are the obectives of financial management=
8. What is financial management=
>
9. .efine financial management.
:. What is profit ma*imi&ation=
;. What is wealth ma*imi&ation=
<. What is financial plan=
>. Mention the steps in financial plan.
(?. What is financing decision=
((. What is investing decision=
(3. What is dividend decision=
(7. -*plain the need for financial planning.
(8. /ow should the finance function of an enterprise be organi&ed= What
functions are performed by the financial manager in this direction=
(9. In what respect is the obective of wealth ma*imi&ation superior to the profit
ma*imi&ation= )naly&e.
(:. What are the various factors considered while drafting a financial plan for an
industrial concern=
(;. What is financial planning= -*plain the principles governing a sound financial
planning.
(<. -*plain the functions of financial management.
(>. #%rofit ma*imi&ation is the basic goal of a Finance Manager$. .o you agree=
.iscuss.
3?. -*plain the functions of a ,ontroller and a Treasurer.
(?